Your firm is considering leasing a radiographic x-ray machine. The lease lasts for 3 years. The lease calls for 4 payments of $25,000 per year with the first payment occurring immediately. The computer would cost $140,000 to buy and would be straight-line depreciated to a zero salvage value over 3 years. The actual salvage value is negligible. The firm can borrow at a rate of 12%. The corporate tax rate is 40%. This lease would be classified as a(n):
A) operating lease because the asset will be obsolete.
B) operating lease because there is no amortization.
C) leveraged lease because it is being financed.
D) capital lease because the lease life is greater than 75% of the economic life.
E) sale and leaseback because the company gets full use of the asset.

Question

Quizplus · Accepted Answer

This lease should be classified as a capital lease because the lease life of 3 years is greater than 75% of the economic life of the asset, which is also 3 years. In addition, the lease payments cover almost the full cost of the asset, which is another indicator of a capital lease. The lease is not a leveraged lease because it is not being financed by a third party. The lease is also not an operating lease because it meets the criteria for a capital lease.

Your Firm Is Considering Leasing a Radiographic X-Ray Machine